Escalating Violence, Collapsing Economy

"Urgent action was necessary, decisive measures were taken by Ukraine, and decisive measures have just been taken by the IMF."

So spoke IMF Managing Director Christine Lagarde on Wednesday, announcing her Executive Board's approval of $17.01 billion to support Ukraine's economic reform program. The loan is a two-year Stand-By Arrangement, by which is meant it will be disbursed over two years - with $3.2 billion available immediately - and the remainder subject to, as the IMF noted in its press release, "frequent reviews". It aims at "restoring macroeconomic stability, promoting sustainable growth, and strengthening economic governance and transparency". In non-IMF-speak, it's a bail-out for an economy on the brink of collapse, with unsustainable indebtedness, depleted international reserves, and a political and business legacy of endemic corruption.

That the loan is being advanced at all represents something of a leap of faith for the IMF, and a tribute to the new government in Kiev. In place only since February, Interim Prime Minister Arseniy Yatsenyuk's administration, in consultation with visiting IMF experts, has devised, in record time, and in the face of, first, Russia's annexation of Crimea, and then mounting violence in Eastern Ukraine's cities, a broad and deep reform program that includes commitments to maintain a flexible exchange rate, restrain wage increases to productivity growth, ramp up financial regulation, gradually reduce both the massive government deficit and that of state-owned energy provider Naftogaz (which together account for an unsustainable 12% of GDP), and strengthen governance, transparency and the overall business climate. The program also aims to radically alter energy policy, in a country that depends on Russia for almost all its imported natural gas, most of its crude oil, and all of the enriched uranium required to run its nuclear power plants.

Just one of these elements taken alone would constitute an ambitious plan for any new government, especially one facing Ukraine's daunting economic and dangerous political circumstances. The reforms, if implemented, would be a dramatic break with the past. And the government appears to have taken strong ownership of the program, believing they have a narrow window of opportunity. But already there are threatening signs: Ms. Lagarde spoke out just one day after announcing approval of the stand-by facility, warning that "further escalation of tensions with Russia and unrest in the east of the country pose a substantial risk to the economic outlook". And in a staff report issued Thursday, the Fund was very clear in noting that "should the central government lose effective control over the east, the program will need to be re-designed".

The ongoing violence this weekend in Eastern Ukraine, and in the Black Sea port city of Odessa, suggest that the Kiev government may have already lost control. It seems virtually certain that, until/if conditions stabilize, the government's reforms, the IMF's money, and the $15 billion of additional funds that the Fund's loan would unlock from other donors including the World Bank, EU, Canada and Japan, will be held in abeyance. It also appears virtually certain that national elections scheduled for the end of this month will be cancelled. Full-scale civil war, fomented by continuing Russian support of activists, is not unimaginable, and Western sanctions against Russia, even if expanded, may be impotent in preventing it.